Interview with Luxembourg's Prime Minister Jean-Claude Juncker

EO：What was your reaction towards the downgrading of Ireland and Portugal's bonds?

PM: I was a little bit surprised when looking at the downgrade. I don't think that it is in line with the tremendous efforts the Irish government has taken. Because this downgrading has occurred just two days before Ireland will go to the financial markets. I don't think this is correct. The basic problem is that our international partners want us to find a way to consolidate our public finances while making efforts not to hamper growth prospects. That is what we are working on and I am confident that we will find a solution soon.

EO: Will this have a large negative impact on the whole situation?

PM: I have noticed with some satisfaction how the euro reacted to this. The Euro actually appreciated yesterday. Normally, when this kind of news emerges, the euro suffers, but now I did not see that happen. So I do not think that it will have a major influence on the markets.

EO: Will this have negative effects on the auctions of Ireland's bonds?

PM: I hope not. This auction will take place tomorrow.

EO: There has been a bizarre picture between the market reactions and government announcements. You said, the EU is very serious about this stress test, and it is conducted professionally. But at the same time, you said you do not expect a major catastrophe after this test. There have been some doubts in the market that the government has the results first, then set standards to perform the test. How do you respond to these doubts?

PM: I don’t have the conclusion which is to be published on Friday; I also don’t have in depth information. But I guess that the result of the stress test will show that European banks are rather solid. They ask what do you think will be the results. I don’t have the information but I have my own impression.

My knowledge as far as the methodology was concerned, it has been done very professionally, without government inference. It’s up to those who are in charge of the test.

EO: Where does your confidence come from?

PM: My knowledge of European major banks is based on my understanding rather than based on the preliminary test results. It’s from my professional basis, because I have contact with the people in charge of the banking sector which indicates we will have difficulties in small banks. But, in any case, if problems should arise in individual cases, the Eurogroup has already agreed that governments will, if needed, stand ready for the recapitalization of their banks.

EO: In your opinion, how much will this stress test will disclose?

PM: I am in favor of total openness. If you conduct the stress test, it must be clear, open and frank. Stress test will not have any important effects of the government and the doubts will prevail banks have taken, everything will be presented in complete transparency.

EO: Do you mean bank-to–bank , very detailed results?

PM: It is in the best interests of the banks to have as detailed results as possible.

EO: Does this total openness and transparency have the consent of all the financial ministers within the eurozone?

PM: I think European ministers have common opinions that support a total openness approach about the banking stress test.

EO: Because the market is very worried that there has been so little information given about the stress test now...

PM: By the way, it shows nobody knows what will be outcome. The markets are nervous because they think governments may hide behind the stress test which is not the case. We expect seriousness and transparency.

EO: So you are optimistic towards the outcome of the test; the market will buy it and calm down?PM: I hope the market will buy it which largely depends on the way the results will be made public. But I guess that the result of stress test will show that European banks are rather solid.

EO: Do you think Spanish banking will be the first to use the EFSF mechanism?PM: The Spanish Finance minister will be the first to react this question. I’ve talked to the Spanish Finance minister, my impression is that the Spanish banks are ready to recapitalize if a problem occurs.

EO: So you believe the Spanish government has taken sufficient measures, the merger and recapitalization of the banks to ensure the stablity of the market?PM: Yes.

EO: What is the current situation of the EFSF? All set? All the money?PM: All the 16 governments have signed up to the financial stability facility framework agreement, by the end of the month of July we will have the necessary capital to start operations if needed, so everything will be in place.There have been some political differences among the governments as you know. I have a meeting with Slovakia's Finance Minister which indicates that they will endorse the commitment. The Greek government has done so, so there are no other major concerns.

The Slovakian government has signed the agreement, and we are currently waiting for the approval of Slovakia, Belgium and Italy's parliament. We anticipate that everything will be ok before the end of this month. Political agreements have been signed. Then it will be about how the money will be distributed.

EO: What do you think about the nature of SPV. Whether it should be a permanent or temporary mechanism?PM: It is now a temporary instrument which limited to three years period. And we will have to check in the framework of EU President’s Van Rompuy’stask force whether we should pursue this instrument in a different form by giving it a more permanent structure.

Of course after these three years, the instrument will have to stop, we will then have to see what should be done. We should review what it has been performing within this three years period, then we will decide what will happen after the three years.

EO: But do you think there should be a permanent institution in charge of financial stability?PM: I think we should have a permanent institution to deal with problems of this kind. I think this permanent institution will have to put into place a mechanism to ensure financial stability by assisting countries in need, but this assistance will have to based on a very strict policy to exclude the possibility of moral hazard. So, yes to a permanent mechanism but only if it combines strong conditionality and exclude moral hazard.

EO: To limit the potential liabilities of the EFSF emergency funding facility, do you think the eurozone should allow governments to default and the restructure?PM: We are not in favor of a mechanism to restructure a sovereign debt. At the moment, restructuring is not an option. In the future when we will put in place a more permanent mechanism, this problem could be discussed, but in current circumstances, restructuring debt is not an issue.

EO: EFSF includes "peer review" - from a monetary union to a fiscal union. Do you think that is a move towards that direction?PM: I don’t think the instrument is paving the way to a fiscally- transferable union inside European union. But we have to acknowledge that our instruments are not perfect, and have to elaborate later on the deepening of a so-called consolidation process inside the eurozone. Therefore, we have to be aware that this could easily lead to a moral hazard among member states. It is too early to talk about the transfer, but the debt crisis has clearly told us that you have to put in place better instruments, allowing us to better deal with a future crisis.

EO: There are two problems, a liquidity problem and a solvency problem. Now it seems that liquidity issues have hijacked the solvency problems to be the focus of attention, how do you see the two problems?PM: I think the result of the stress test will show us. It depends on the result of the stress-test, dialogue between the liquidity and solvency will carry on after we know the result.

EO: Do you see the solvency issue of Greece and Spain becoming a major trigger of a future crisis?PM: To me, I think the Greek government is dealing in a proper way. The first thing one should acknowledge is that the Greek deficit has been reduced by 50%. The other thing is Spain has launched a very credible consolidation program, so I think these situations are under control. And you have to consider that before the crisis we did not have the instruments at that time. Now, it has been put in place.

EO: Could I borrow your wisdom to see how this sovereignty debt crisis will further evolve?PM: The debt crisis has shown that member states of euroareas have applied weak budget discipline, those members states which have ended up with major difficulties are those who do great harm to the growth and stability. But all those governments have now begun to consolidate their budgets. Actually, all the member states of Germany, France, Portugal, Italy, Spain and Greece

EO: Do you see a weaker euro as an outcome of the crisis and its impact?PM: I’m not going to speculate on the currency. But if you look at the market, the euro has lost 10% of its value against the dollar in June, but now euro has climbed to 9% against the dollar. So ,there is a great volatility in the market and the exchange rate is determined by day-by-day events.

EO: What are the root causes of this crisis, what should the eurozone change in order to better cope with the situation?PM: That's difficult to say. The real problem is the the growth problem of the EU and the eurozone as a whole. We are the part of the world where the growth rate is far behind the US and emerging economies in Asia. What we are supposed to do is to strengthen the conditions which will allow to reach higher growth. We are expected to increase growth potential, which is clearly too low in Europe to afford the costs of social needs.

EO: China’s buying European government bonds, and increasing investments in Europe. What does this crisis mean for China? PM: I think this crisis has shown that China is one of the major economic powers worldwide. This shows that China has to take more responsibilities, especially in terms of monetary policy. We have been in discussion with the Chinese authorities, the prime minister and the central banks and have urged them to consider a more flexible monetary path. I have noticed with pleasure that Chinese authorities have engaged in a more flexible monetary policies. However, this will not lead to a satisfactory result in the short term. We are waiting to see the further solution of the RMB which is undervalued by the euro, but is now moving in the right direction.

EO: What do you think of trade frictions? PM: The trade problem is partly a result of the monetary policies adopted both in China and in Europe. I think in the medium term, these trade frictions are global issues.

EO: What do you think is the way out of the crisis given weak domestic demand and investment? Will Europe will face 5-10 years of a low growth rate like Japan? PM: The main problem of the eurozone is that we are lacking growth, and we have to implement policies leading euroareas from weak growth. We will take several years to consolidate our problematic public finances, and make sure the spending cuts will not harm the economic growth; this is a process we will constantly check in the European area. We have to know how particular national measures which have been taken or could be taken in a member state influence economic growth in other member states or in the Euro area as a whole. Just like the consolidation programmes， we will have to permanently discuss these issues in the Euro zone to reach a much higher level of policy coordination.

Paul Pennay contributed to the preparation of questions for this interview and Tony Liu translated the interview into Chinese.

The above transcript is of an interview with Luxembourg's Prime Minister Jean-Claude Juncker which was conducted on Tuesday July 20, 2010 at the Ministère d'état on the rue de la Congrégation in Luxembourg. The interview is just one of a series of interviews that Paul and Zhang Feifei conducted with various officials, scholars and journalists throughout Europe on the topic of the future of the European economy in the wake of the sovereign-debt crisis. You can find a collection of the interviews in English here and in Chinese here.